The growth and maturity of nationwide online retail commerce poses one of the greatest tests for state tax administrators to respond to new, rapidly changing technology. This calls for new tools to ensure fairness and impartiality. The way to accomplish this is to unleash the Board of Equalization and let it be a watchdog for evenhanded tax enforcement in the new marketplace.
Many businesses are seeking to shift a tax burden to consumers for tax traditionally collected by retailers. For example, many consumers visit traditional retail outlets to browse or sample books, tools, clothes, or any myriad of consumer items now sold on the Internet. Then an online retailer takes advantage of consumers’ expectation that these purchases are tax-free, underselling a local retailer who isn’t competing on an even field.
Businesses selling in-state to consumers must collect sales tax from their customers. When consumers purchase from out of state, they owe “use” tax, adopted by the Legislature in 1935 to ensure out-of-state commerce is treated equally to in-state commerce.
The upsurge of online commerce allows remote retailers to avoid state laws – including tax laws – whose reach is limited to individuals and businesses who can take advantage of state and local taxpayer-funded benefits. However, non-tax laws apply evenly to remote nationwide businesses as they benefit from accessing California markets. State law gives enforcement agencies and courts the full authority of the constitution, ensuring enforcement of state law and removing legal hurdles raised by law breakers and scofflaws.
However, for sales tax and use tax, the U.S. Supreme Court has said a state’s taxing jurisdiction is limited to businesses with a “physical presence” in the state. Physical presence usually takes the form of facilities such as stores, warehouses, or transportation equipment or permanent or temporary employees. State law has attempted to describe these things in ways that were once state-of-the-art, but now have not kept up with changing technology. By not doing so, current law encourages tax evaders to use loopholes to avoid tax obligations and exploit an uneven competitive advantage.
Some urge abandoning the traditional collection by retailers, allowing them to shift that burden to their customers. However, with an average use tax owed of $61 by households and $102 by businesses, the amounts are too small to be collected from each consumer individually, almost guaranteeing that revenues supporting schools, public safety, and health care go uncollected.
A recent BOE estimate of $1.3 billion in use taxes owed, but unpaid – the “use tax gap – was premised on data showing individual consumers do not pay their use tax. In a recent, unscientific online poll by the Los Angeles Times, six out of seven respondents said they would not report tax on their out-of-state online purchases. In fact, one newspaper columnist ridiculed me as “the most optimistic woman in California” for urging Californians to pay their use tax.
State lawmakers have been debating how to fix this problem for over a decade. Ten years ago, the focus was “dot.com” affiliates of traditional retailers, such as Borders.com and BN.com. Now those businesses comply with California law, facing uneven competition from pure online retailers with no traditional physical outlets, when they avoid use tax collection.
Some newer online retailers, such as Amazon.com, have loose marketing arrangements with affiliated small retailers who run small websites in California or mention Amazon.com in their local marketing. Defining these marketers as “physical presence” – as enacted recently in New York – is one proposal recently reintroduced in the Legislature.
Legislators have debated other proposals including: requiring Internet marketers to advertise Californians’ use tax obligation; treating combined business groups as a single retailer; strengthening the state’s use of income tax forms to collect use tax, and sending notices to individual businesses, based on BOE analysis of their federal income tax returns.
A common theme among all of these proposals: requiring both in-and-out of-state retailers to collect sales and use taxes on an equal basis is the most efficient way to collect taxes fairly with the greatest convenience to consumers. No one proposal guarantees fair and effective collection of taxes to close the $1.3 billion tax gap lost each year – generating needed revenue from taxes already owed by businesses benefitting from loopholes in an aging law.
Piecemeal proposals debated over the last ten years have failed to pass because they have not gone to the root of the problem – an outdated law cannot keep up with rapid change. As long as there is a sales and use tax – raising one-third of the state’s revenue – the BOE will need the full authority of the U.S. Constitution to enforce interstate online tax laws in order to be a fully equipped effective watchdog requiring online retailers to compete equally, protecting consumers and competitors, while collecting the tax obligations they avoid.